Monday, May 6, 2013

Fear and Loathing in the CPI

From  Article I, Section 8 of the US Constitution, aka the Enumerated Powers of Congress:
 The Congress shall have Power To... coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;
A standard weight or measure might be something like a nautical mile or a dram. Even a standard barrel might count*. An ounce is subject to regulation, but a "box" ain't. Curiously, few folks meandering the aisles of your local grocer buy in bulk, so it's almost unheard of to hear "honey, would you pick up 100 grams of toothpaste while you're out?" We buy by the bottle, by the tube, by the loaf, by the case. In other words, we anchor to non-standard units.

And vendors know this. They also understand very well two important vagaries of human nature, both linked to folks' natural tendency to economize on costly information-gathering: it takes quite a shock to jar people from the money illusion and in a cacophony of communication, a lot of relevant information is easy to drown.

This should be intuitively obvious to anyone who's walked into a store. Tell me... do you take the time to do a careful comparative analysis of the nutrition information of each and every food item you purchase, recording panel data along the way and conducting detailed econometric analysis to determine the ideal combination of grocery items? Or are you more like me and you just buy what's on the list, trying 3/4ths-heartedly to avoid buying dairy products that have exceeded the sell-by date? Sure, you know that all those processed foods have filler in them, but did you run a spectrographic analysis to determine what they actually are? Noooooope. Probably nope. Producers know you're a busy person with more important stuff to worry about than whether or not that box of brown sugar is a little bit smaller than the last time you bought it. Or that those fish fingers are a lot more breading and a lot less fish these days. Time is money and every second you spend fretting over the bacon bits is time away from Game of Thrones or whatever it is people are up to these days.

You see, sellers care chiefly about the direct relationship they have with their customers. But there's this little finch sitting on their shoulders. BLS mooks scribble down posted prices and convert that into an index that takes every conscious effort to mimic a typical American consumer. You can read more about the process here. The point is, the BLS folks will treat a bottle of shampoo like a bottle of shampoo, even if it was 24 oz last month and now it's only 22. These figures get drafted into COLA adjustments to transfer payments in a pathetic Ouroboros where the guy trying to get an accurate measure has to stand on the scale to reach the balance beam.

This is all obvious stuff. It's not even the most important critique of the CPI (not by a long shot), but it is the one relevant for euvoluntary exchange. If sellers can "cheat" on the margin by playing fast and loose with package contents and if this jiggering fools both real consumers and the price index, we've got a whole lot of unintentional uncertainty going on. We've got market competition, which tends over time to push prices down, but we've also got a monetary authority who has elected to subscribe to the notion that mild, predictable inflation is good for "the economy" (another metaphor I have a bit of a problem with), and we've got consumers on autopilot who just can't afford the attention needed to stay on top of FOMC operations as needed to isolate relative price changes from inflation. If the alternative is between a state of the world with no elite tinkering of the "price level" (ibid, metaphor) and the status quo, it's not entirely clear to me that there's a slam-dunk case against an unencumbered general equilibrium.

More to the point, the efforts firms waste by fiddling with deceptive packaging thanks to the FRB's policies would probably be better spent improving the actual product. Ditto for the talent employed by the agencies whose job it is to measure the water level of the tub they're standing in.

*The abbreviation for barrel is 'bbl', which comes from Standard Oil. Rockefeller had the same sort of problem I discuss here, except he was the sole buyer. Time was, the derrick workers would snag any old barrel they had lying around and slop the crude right in. Oil contracts were written by the barrel, so it was in ol' JD's interests to standardize the contents thereof. Hence, the "Blue" Barrel (that's the first 'b' in bbl), a uniform 55 gallon blue barrel. Curiously, vertically integrated firms began using the designation, even for non-standard volume barrels like the ones used by distillers and winemakers. Next time you're drinking your oaky chardonnay, try not to think of Daniel Day-Lewis's performance in There Will Be Blood.

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Do you have suggestions on where we could find more examples of this phenomenon?